Aurizon win lands with a punchline

Aurizon would do well to put an apparent concession on cost recovery by the Queensland competition regulator in an in-tray labelled "careful what you wish for".

In yet another unexpected twist in the bizarre bust-up between the operator of the Central Queensland Coal Network and just about every one of its critical stakeholders, the Queensland Competition Authority has found itself "favourably disposed" to Aurizon's pitch for an increase in the maintenance costs it can recover from its customers.

To refresh, in a draft decision released just before Christmas, the QCA recommended a cap on network pricing for the next four years that fell $1 billion shy of what Aurizon had asked for. And, within that new pricing matrix, the regulator pruned the maintenance cost that Aurizon could charge its customers by $100 million.

The regulator has signalled it may well accept a revised Aurizon claim that would lift a limit on recoverable cost from the draft proposal of $817 million over four years to $927 million. To put that flagged back-flip into context, the QCA is now disposed to increase cost recovery by about $11 million over the term of the regulated term rather than reduce it by $100 million.

Needless to say, this conditional concession by the QCA is pretty good news for Aurizon. But, true to the classic punchline, this encouraging good has arrived with a weight of ominous bad.

"The Queensland Competition Authority encourages Aurizon Network and its customers to concurrently engage with each other in order to reach a pragmatic consensus on these matters," it said. Robert Shakespeare

But before we go there, it is worth acknowledging that the QCA's paper arrived with some very, very good advice to all concerned. After observing that its final decision "will have regard to stakeholder submissions", the QCA appeared to call on Aurizon and its customers to chart the way out of a problem that the regulator and its legislative framework has created.

"Constructive engagement is in the best interests of all parties," the regulator advised. "We encourage stakeholders to collaborate, discuss and, where possible, provide joint submissions. To this end, the QCA encourages Aurizon Network and its customers to concurrently engage with each other in order to reach a pragmatic consensus on these matters," it said.

Now, this idea is so on the money that, in fact, it is already a process in train, so to speak.

To the wrong-headed public frustration of the Queensland Resources Council, it appears that Aurizon management has reached out directly to the coal miners and their logistics operators to manufacture some level of alignment on what it should cost to use the network and how best to operate the thing.

In outing Aurizon's move to direct negotiation with individual miners, the QRC chief executive Ian Macfarlane rather unhelpfully characterised the company's tactics as thuggish, and asserted the attempt to directly refine an acceptable consensus was an attempt to sideline the QCA.

Far from feeling undermined by being by-passed, the regulator has recommended this path as the most productive way forward.

What makes this development so interesting is that this move to develop a consensus industry position is exactly what happened in the Hunter Valley. The coal network in NSW is run by the Australian Rail Track Corporation and it is regulated by the Australian Competition and Consumer Commission. When the regulated and regulator could not see eye-to-eye on access pricing last year, ARTC and the coal industry got together and developed a solution that was then accepted by the ACCC. In doing that the industry agreed to pay a return that was based on a higher weighted average cost of capital than the ACCC assessed as appropriate.

Aurizon is chewing on two rich bones of contention that arrived in the QCA's draft decision. There is the aforementioned cost recovery and then there is the more important return on capital component of the maximum allowable return (MAR) that is set by the QCA.

Aurizon's original submission asked approval for $1.592 billion based on a weighted average cost of capital of 6.78 per cent. The QCA draft identified that a WACC of 5.41 per cent was a more appropriate metric and as a result Aurizon was offered $1.289 billion as its return on capital number.

Aurizon responded to that the observation that the ACCC and the coal industry had accepted that a WACC of 6.3 per cent in the Hunter Valley. Aurizon noted too that the CQCN was a patently more risky enterprise than the Hunter. That is because it lives in more cyclone prone country and because it is a narrow gauge network and thus is more derailment prone than the standard gauge Hunter system.

Critically, the QCA consultation paper released late on Tuesday contains itself to the maintenance component of its disputed draft recommendations. There is no evidence that the regulator is preparing to release a similar paper on the return on capital component of the MAR. Then again, there was no evidence that Tuesday's missive was on the way either. So, outside of those clever clogs at the QCA, who knows what might be on the cards?

Which brings us back to the classic punchline: and the bad news is …

Outside of the detailed and moderated scepticism that qualified the QCA welcome of Aurizon's new maintenance claims, the consultation paper concluded with a collection of new discussion points that seem to me to mark profound regulatory mission creep.

In response to coal industry submissions and to the operational changes Aurizon has pursued in the wake of the draft decision, the QCA has invited views on issues that range from whether or not the introduction of some sort of network incentive scheme might inspire better outcomes from Aurizon to a firm redefinition of the operator's obligations to minimise network disruptions.

The first thing to say about the QCA's new discussion points is that it does not quite feel the time to add complexity to a process that has undermined Aurizon's standing with customers to a depth not seen since the business was listed back in 2010.

At best this broadened conversation risks further confusion and delay in a process that is running 11 months behind schedule. To be clear, Aurizon was motivated to temper its maintenance program because the new pricing regime will be back-dated to July last year.

Yet, the QCA now wants to know whether the existing regime "contains appropriate obligations to maintain the network and minimise disruptions to train services or whether changes to enhance the operation of these arrangements are appropriate".

It wants to know whether a "network performance incentive" would help preserve service levels and whether the whole system requires a "maintenance performance monitoring framework".

And here we were struggling under the misconception that the QCA's job was to establish what the price of access to a monopoly rail network should be for a collection of sophisticated customers whose coal is carried by a collection of equally sophisticated train companies.

I mean, here we have a regulator whose previous decision on the terms of access to Aurizon's network (UT4) arrived just months before discussion on the terms of the next agreement were due to begin. As things stand, a final decision on the new access terms will land at least 18 months late. And that is being optimistic.

But rather than sit embarrassed about that, the QCA has decided to kick-start a conversation that broadly asks as whether or not it needs to insert itself directly into the management of the CQCN, a business that lives and dies on its ability to write schedules and stick to them.

The QCA deserves considerable credit for its tentative u-turn on Aurizon's cost recovery. It is always hard to say you got it wrong.

But the disparity between its two draft conclusions stands as reasonable reinforcement of the Aurizon position, which is that the QCA and the legislation it enforces is broken and that this whole situation requires a fix more permanent than just landing on a better pricing outcome.